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I'm wondering if it's possible to have an Ethereum token that is backed by pooled bitcoin (and therefore has 1:1 value parity with Bitcoin) in a trustless way. With tokens issued and destroyed as bitcoin is deposited and removed.

I'm assuming the answer will be no, because the contract would need to be able to issue the private key(s) whenever bitcoin is withdrawn, and that would seem to require a trusted party to provide a key to 'unlock' the contract to do its thing.

But I'm unclear on Ethereum capabilities - maybe the black-box of the contract can 'know' the (hardcoded?) encrypted private key(s), in such a way that it can output a valid, signed bitcoin transaction, only upon contract conditions relating to the contract token being met?

(What I'm really wondering here - is is there a way to subvert the bitcoin scaling issues, by having a trustable, trustless ethereum token, that is almost like a bitcoin sidechain, guaranteed to have 1:1 pegging to bitcoin value, by being provably backed by bitcoin holdings equal to the tokens in circulation.)

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No, currenctly it is not possible to do it in a trustless way.

The difficult part is the interaction between the two chains. To make sure for a valid transaction in the ethereum contract there's a corresponding valid transaction in bitcoin, and viceversa.

There are some alternatives like BTC Relay, but they are not trustless.

There's a similar question: Will Bitcoin and Ethereum be linked/bridged?.

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  • There's no trust involved in BTC Relay, except trusting the Bitcoin miners to mine valid blocks on the longest chain. The problem is that it only works in one direction: It can check what happened on the Bitcoin chain, but the Bitcoin chain can't check what happened on the Ethereum chain.
    – Edmund Edgar
    May 27, 2017 at 0:49
  • You say that there's no trust involved, but then you say "except trusting the Bitcoin miners to mine valid blocks". IMHO the Consensys guys are doing a great job, but their solution is not completely trustless. I'd say is really hard to build such solution, because it will require compromise from both chains.
    – Ismael ♦
    May 30, 2017 at 16:45
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To answer a different part of your question, contracts are not black boxes. The entire code and storage is available for inspection by any external actor. Thus, it's impossible for an Ethereum smart contract to hold bitcoin--anyone could inspect the code and just sweep the keys.

Even if this was not the case, anyone could fork the blockchain and submit a transaction on this personal fork, then take the valid bitcoin transaction and submit it to the real bitcoin network.

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